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Lira Volatility Signals Bold Rate Hike by Turkey, UniCredit Says

(Bloomberg) -- The Turkish central bank is gearing up for a sizable interest-rate increase, if history is any guide.

That’s the view of UniCredit SpA, which says whenever lira’s implied volatility starts trading at a premium to that of its emerging-market peers, the central bank delivers a bold policy response.

That spread widened last week to 1.40 volatility points, a level that has triggered action from the monetary authority in the past, which means the odds of a rate hike and some relief for the Turkish lira have now increased, the bank’s London-based strategist Kiran Kowshik wrote in a research note.

In early 2014, the Turkish central bank pushed average funding rates up by around 300 basis points as the gap between the rate of lira swings and that of its most volatile peer peaked at 2.8 points, UniCredit’s chart shows. A spread of 6 points in early 2017 resulted in more than 400 basis points of tightening.

The central bank next meets on April 25 and speculation has been growing that it will backstop the nation’s assets, which are buckling under the weight of one of the widest current-account deficits among peers and double-digit inflation.

The lira, which fell to record lows against the dollar and euro earlier this month, rallied and Turkish bonds gained on Wednesday after President Recep Tayyip Erdogan called snap elections in June, putting an end to a key source of uncertainty weighing on investor sentiment.

While UniCredit remains bearish on the lira over the medium term, they’ve now taken profit on a short recommendation and “moved to the sidelines” before the monetary-policy decision. The market is currently pricing in between 75 and 100 basis points of rate increase but should the central bank raise borrowing costs by 125 basis points, the lira could rally, according to the Italian bank.